Here is a deeper look at the two lawsuits filed lastweek in U.S. District Court in San Francisco against the City ofRichmond, California, for the city’s Mortgage Resolution Partners-backed plan to condemn underwater mortgages, specifically those held by out-of-state securitizedbonds, residential mortgage-backed securitization (RMBS) trusts. The first Complaint was brought by Wells Fargo and a number of mortgage holders onbehalf of their trusts (“Wells Fargo” suit). The other, filed concurrently, was brought Wednesday bythe Bank of New York Mellon for its trusts(“Bank of NYM suit”).
My Damon Key colleague Bethany C.K. Ace has digested the complaints and provides us with her thoughts on the cases below. She joined me and Mark M. Murakami as the co-author of Recent Developments in Eminent Domain: Public Use, which is forthcoming in the next edition of the Urban Lawyer.
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More On The Two Federal Lawsuits Challenging The Underwater Mortgage Taking Scheme
Bethany C.K. Ace
A review of the program wasearlier posted here. In short, Richmond is the furthest along in implementing its partnershipwith MRP, the investment firm that has aggressively marketed andcontinues to push its program to various municipalities to acquireunderwater mortgages using the power of eminent domain. Accordingto the complaints, Richmond had already contracted with MRP to implement this program.
The suits were filed after thetrustees received offers from Richmond to purchase their mortgages, a statutoryprerequisite in California to initiating condemnation. The trusteesallege that the offers are significantly below the value of the mortgages,particularly given that most of these mortgages are still performing (not indefault or foreclosure), and that the offers are a mere formality because(again as the trustees allege) mortgages in private RMBS trusts cannot be sold.The suits are aimed at “nipp[ing] in the bud” the program before the City attempts to take any mortgages.
The two lawsuits raise largelythe same allegations and seek the same relief, declaratory and injunctiverelief to invalidate the program before the mortgages are condemned asviolating a host of U.S. Constitutional, California Constitutional andCalifornia statutory provisions. The main thrust of both complaints is the trustees’claims that the program is not for a publicuse. A municipality has the power to takeproperty by eminent domain, but these powers arenot limitless. TheUnited States and California Constitutions require that thecondemnation of private property must be for a“public use.” The lawsuits claim that Richmond has no public use because the program seeks to move the property (the debts) fromone private entity to another (i.e., a private taking) and that the city’s purported reasoning (to prevent foreclosures and their attendant economiceffects) is mere pretext. The Bank ofNYM suit also claims that Richmond’s reasoning amounts to a claim for “preventionof future blight or harm” and such reason, even if true, “is not avalid public use.”
These arguments put the lawsuitsquarely in post-Kelo country, wherecourts and practitioners continue to try to delineate when a proffered use or purpose is pretext for an impermissible private benefit. Notably,the two lawsuits vary on the depth of their analysis of the statements Richmondhas made to demonstrate pretext — Wells Fargo quoting more of the statementsmade to support the program (e.g., that the program will create “morestable neighborhoods,” add “more money in our local economy tostimulate community wealth,” and save homeowners money on their mortgagepayments and put that money in “homeowners’ pockets” to spend inlocal businesses). The general rebuttalto these statements is that the natural of the program ipso facto demonstrates pretext because only certain mortgages willbe condemned, ones that meet the profitability model of MRP (namely, performing mortgages with owners/borrowers who are goodcredit risks). At this early stage, itis hard to tell what additional statements will be presented to demonstratepretext. As takings veterans andfrequent readers of this blog well know, proving pretext is easier said thandone.
The municipality must also meet any additional constitutional or statutory requirements imposed onthe use of that power. For example, eminent domain cannot be invoked to condemn property locatedoutside the jurisdictional limits of the condemning authority. And incondemning property, the municipality can also run afoul of myriad otherlaws.The trustees also claim that the programviolates the following constitutional and statutory provisions (Bankof NYM alleging most of the same):
- Violation of prohibition against extraterritorialseizures under the U.S. Constitution, California Constitution, and the CaliforniaCode of Civil Procedures because the situs of a debt for eminent domain purposesis the location of the creditor and the creditor of the debts and thepromissory notes are located outside of Richmond.
- Violation of the Commerce Clause ofthe U.S. Constitution, under the “dormant Commerce Clause” doctrine which states and their political subdivisions are prohibited from taking actiondesigned to benefit in-state economic interests by burdening out-of-state interests(claiming that the program “would significantly and directly regulate [theRMSB] market” on a national level and that the “burden imposed on interstatecommerce by the Program would be excessive, and would greatly outweigh any purportedbenefits to the Richmond community”).
- Violation of the Contracts Clauseof the U.S. Constitution because the programwould “severely impair the Trust’s contractual rights to receive fullpayments of unpaid principal from borrowers” (i.e., “abrogate debtsof [Richmond’s] citizens, … impair commercial intercourse and threaten theexistence of credit”).
- Violation of the Just Compensationrequirements of the Takings Clause of the U.S. and California Constitutions, claimingnot simply unjust compensation for any particular debt, but that unjustcompensation (paying less than the fair market of the debts) “is thecentral premise of the Program itself.”
- Violation of the same requirementsfor a partial taking by “cherry-picking” certain performing mortgagesout of the portfolio of the RMBS trusts, leaving a higher concentration of non-performingloans, “thereby diminishing the value of the Trust’s remaining, non-condemnedassets.”
- Violation of the Equal ProtectionClause of the U.S. and California Constitutions by discriminating againstout-of-state RMBS trusts (which hold the only mortgages targeted by theprogram) and that “such discrimination is not rationally related to anylegitimate purpose.”
One of the more interesting facets of the arguments concernsthe location of the loans and their notes and the role of interstate commerce under the dormant Commerce Clause doctrine. If these arguments win the day, many of these mortgageforeclosure programs would be dead in the water because most debts would belocated outside of the jurisdictional limits of the condemning government and anadverse finding in this case would signal that municipalities could not touchthese mortgages even if they encumber properties within their jurisdictionallimits.
But a reading of the lawsuits and all this news coverage andcommentary shows that the biggest issues withthe program is whether under the program “justcompensation” is being offered and whether it will actually be paid. The Bank of NYM lawsuit givesan example ofan offers being made at 11% ofthe outstanding principal balance. As required in California, the condemnor must pay the “fairmarket price” which is statutorily defined (“the highest price” thata willing but economically unpressured buyer would voluntarily pay to and beaccepted by a willing but unpressured seller, i.e., arm’s length transaction,on the date of value, giving due consideration to the property’s features andpotential uses, including its highest and best use).
The trustees take issue with howRichmond calculates the value of these loans, noting for example that thevaluations do not account for things like consistent payment history. They alsoclaim that the valuations will remain at the “artificially” loweramount if Richmond condemns the mortgages. The trustees point out that for the scheme to work, the mortgages haveto be condemned at a price much lower than the current balances or what trusteescontend are the “fair market value” of these debts, so that the homeowners can qualify for the newloan and the city and its partners can turn around and sell the securitizedloan at a profit. Yet the trustees seek to havethese issues vetted before any condemnation occurs, based on a claim ofimmediate and irreparable harm, as opposed to a challenge raised during a condemnation,requiring the trustees to meet the additional burdens required of those seekinginjunctive relief and also raises questions of ripeness, another favorite issuefacing those challenging takings.
And the plot continues tothicken… From the looks of it, there will be a battle both in thecourtroom and on the street — Wall Street — as Richmond and perhaps othermunicipalities test using their eminent domain powers on underwater mortgages. For its part, Richmond claims to be ready for thefight. “The fact that these threats arebeing put out there are (sic) very, very disturbing — but we are not afraid togo to court,” said Richmond Major Gayle McLoughlin, as reported in this L.A. Times story. The story also reports that shortly after the lawsuits werefiled, the Federal Housing Finance Agency fired a shot across the bow and announced it wouldinstruct Fannie Mae and Freddie Mac to “limit, restrict or cease businessactivities” in any jurisdiction using eminent domain to seize mortgages.
These cases should be ones to watch, so stay tuned.